Recently, there has been a proliferation of software packages released that claim to help individuals make better investment decisions. Prior art investment software packages often utilize portfolio optimization methods to make specific security investment recommendations. Generally speaking, portfolio optimization refers to the process of maximizing the expected return on a portfolio for a pre-specified level of portfolio risk. Software packages that utilize portfolio optimization typically do not consider the tax consequences associated with investment decisions. As such, this class of portfolio optimization based software is only useful for making investment decisions within non-taxable accounts, such as 401(k) accounts.
The importance of considering taxes in the portfolio optimization problem is well established in the prior art. Techniques for performing portfolio optimization when investors are subject to taxes are discussed in the prior art, but these techniques typically apply to investors making investment decisions within their taxable account only. Some techniques ignore existing investments for which capital gains taxes might be due if a sale is recommended. However, making investment decisions within the context of the investor's entire portfolio, which can include both taxable and non-taxable investment accounts, is a generally accepted tenet of modern portfolio theory.
What is needed is an investment system that makes investment recommendations within both taxable and non-taxable accounts and considers the consequences of those decisions within the context of the investor's entire portfolio. More precisely, an investor typically has a set of financial securities, an “investment universe,” that she can choose from when making investment decisions in her taxable account. This investment universe may or may not be the same as the universe of financial securities that she can choose from when making investment decisions in her non-taxable account. It is desirable to have an investment system that maximizes the investor's expected portfolio return after taxes for a level of portfolio risk that is determined by the investor's risk tolerance and provides investment recommendations within both taxable and non-taxable accounts. The output from this system could include specific dollar amounts, or investment percentages, to be invested in those financial securities included in the taxable investment universe and specific dollar amounts, or investment percentages, to be invested in those securities included in the non-taxable investment universe.